3. The NBA Corporation is comparing two different capital structures, an all-equ

Question

3. The NBA Corporation is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, NBA would have 200 shares of stock outstanding. Under Plan II, NBA would have 100 shares of stock and $5,000 in debt outstanding. The interest rate is 12 percent and there are no taxes. (a) What is the break-even EBIT; that is, what EBIT generates exactly the same EPS under both plans? (b) If EBIT is $1,000, which plan results in the higher EPS? (b) If EBIT is $2,000, which plan results in the higher EPS?

Explanation / Answer

a)

EBIT÷200 = (EBIT-600)÷100

EBIT = 2×EBIT-1,200

EBIT = $1,200

b) 100% equity 100 shares EBIT $          1,000 $       1,000 Less: Interest $          600 Net income $          1,000 $          400 No of common stocks                  200               100 Earnings per share $             5.00 $         4.00 100% equity has highest EPS C) 100% equity 100 shares EBIT $          2,000 $       2,000 Less: Interest $          600 Net income $          2,000 $       1,400 No of common stocks                  200               100 Earnings per share $          10.00 $       14.00 100 shares has highest EPS

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